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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended April 1, 2017

 

Commission file number 0-21835

 

SUN HYDRAULICS CORPORATION

(Exact Name of Registration as Specified in its Charter)

 

 

FLORIDA

 

59-2754337

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

 

 

1500 WEST UNIVERSITY PARKWAY

SARASOTA, FLORIDA

 

34243

(Address of Principal Executive Offices)

 

(Zip Code)

 

941/362-1200

(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer

 

 

Accelerated filer

 

 

 

 

 

 

 

 

Non-accelerated filer

 

 

Smaller Reporting Company

 

Emerging growth company

 

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  

The Registrant had 27,044,529 shares of common stock, par value $.001, outstanding as of April 28, 2017.

 

 


Sun Hydraulics Corporation

INDEX

For the quarter ended

April 1, 2017

 

 

 

 

Page

 

 

 

PART I. FINANCIAL INFORMATION

 

 

 

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

 

 

Consolidated Balance Sheets as of April 1, 2017 (unaudited) and December 31, 2016

 

3

 

 

 

 

 

Consolidated Statements of Operations for the Three Months Ended April 1, 2017 (unaudited) and April 2, 2016 (unaudited)

 

4

 

 

 

 

 

Consolidated Statements of Comprehensive Income for the Three Months Ended April 1, 2017 (unaudited) and April 2, 2016 (unaudited)

 

5

 

 

 

 

 

Consolidated Statement of Changes in Shareholders’ Equity for the Three Months Ended April 1, 2017 (unaudited)

 

6

 

 

 

 

 

Consolidated Statements of Cash Flows for the Three Months Ended April 1, 2017 (unaudited) and April 2, 2016 (unaudited)

 

7

 

 

 

 

 

Notes to the Consolidated, Unaudited Financial Statements

 

8

 

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

19

 

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

23

 

 

 

 

 

 

Item 4.

Controls and Procedures

 

23

 

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

24

 

 

 

 

 

 

Item 1A.

Risk Factors

 

24

 

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

24

 

 

 

 

 

 

Item 3.

Defaults Upon Senior Securities

 

24

 

 

 

 

 

 

Item 4.

Mine Safety Disclosure

 

24

 

 

 

 

 

 

Item 5.

Other Information

 

24

 

 

 

 

 

 

Item 6.

Exhibits

 

25

 

 

2


PART I: FINANCIAL INFORMATION

Item 1.

Sun Hydraulics Corporation

Consolidated Balance Sheets

(in thousands, except share data)

 

 

 

April 1, 2017

 

 

December 31, 2016

 

 

 

(unaudited)

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

70,406

 

 

$

74,221

 

Restricted cash

 

 

127

 

 

 

37

 

Accounts receivable, net of allowance for doubtful accounts of $286 and $101

 

 

37,714

 

 

 

25,730

 

Inventories, net

 

 

31,915

 

 

 

30,000

 

Income taxes receivable

 

 

-

 

 

 

512

 

Short-term investments

 

 

4,704

 

 

 

6,825

 

Other current assets

 

 

4,979

 

 

 

3,943

 

Total current assets

 

 

149,845

 

 

 

141,268

 

Property, plant and equipment, net

 

 

78,750

 

 

 

80,515

 

Deferred income taxes

 

 

3,921

 

 

 

3,705

 

Goodwill

 

 

104,205

 

 

 

103,583

 

Other intangibles, net

 

 

110,244

 

 

 

112,565

 

Other assets

 

 

2,829

 

 

 

3,141

 

Total assets

 

$

449,794

 

 

$

444,777

 

Liabilities and shareholders' equity

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

14,795

 

 

$

10,166

 

Accrued expenses and other liabilities

 

 

8,921

 

 

 

7,456

 

Current portion of contingent consideration

 

 

10,765

 

 

 

10,765

 

Dividends payable

 

 

2,427

 

 

 

2,424

 

Income taxes payable

 

 

4,040

 

 

 

265

 

Total current liabilities

 

 

40,948

 

 

 

31,076

 

Revolving line of credit

 

 

124,000

 

 

 

140,000

 

Contingent consideration, less current portion

 

 

24,312

 

 

 

24,312

 

Deferred income taxes

 

 

9,581

 

 

 

9,501

 

Other noncurrent liabilities

 

 

3,640

 

 

 

3,491

 

Total liabilities

 

 

202,481

 

 

 

208,380

 

Commitments and contingencies

 

 

-

 

 

 

-

 

Shareholders' equity:

 

 

 

 

 

 

 

 

Preferred stock, 2,000,000 shares authorized, par value $0.001, no shares outstanding

 

 

-

 

 

 

-

 

Common stock, 50,000,000 shares authorized, par value $0.001, 27,037,015

   and 26,936,021 shares outstanding

 

 

27

 

 

 

27

 

Capital in excess of par value

 

 

91,309

 

 

 

89,718

 

Retained earnings

 

 

169,730

 

 

 

162,485

 

Accumulated other comprehensive loss

 

 

(13,753

)

 

 

(15,833

)

Total shareholders' equity

 

 

247,313

 

 

 

236,397

 

Total liabilities and shareholders' equity

 

$

449,794

 

 

$

444,777

 

 

The accompanying Notes to the Consolidated, Unaudited Financial Statements are an integral part of these financial statements.

 

 

3


Sun Hydraulics Corporation

Consolidated Statements of Operations

(in thousands, except per share data)

 

 

 

Three months ended

 

 

 

April 1, 2017

 

 

April 2, 2016

 

 

 

(unaudited)

 

 

(unaudited)

 

Net sales

 

$

81,353

 

 

$

51,028

 

Cost of sales

 

 

48,559

 

 

 

31,487

 

Gross profit

 

 

32,794

 

 

 

19,541

 

Selling, engineering and administrative expenses

 

 

14,700

 

 

 

7,468

 

Amortization of intangible assets

 

 

2,310

 

 

 

187

 

Operating income

 

 

15,784

 

 

 

11,886

 

Interest expense (income), net

 

 

625

 

 

 

(372

)

Foreign currency transaction gain, net

 

 

(46

)

 

 

(114

)

Miscellaneous expense, net

 

 

66

 

 

 

176

 

Income before income taxes

 

 

15,139

 

 

 

12,196

 

Income tax provision

 

 

4,928

 

 

 

3,988

 

Net income

 

$

10,211

 

 

$

8,208

 

Basic and diluted net income per common share

 

$

0.38

 

 

$

0.31

 

Basic and diluted weighted average shares outstanding

 

 

26,946

 

 

 

26,804

 

Dividends declared per share

 

$

0.11

 

 

$

0.13

 

 

The accompanying Notes to the Consolidated, Unaudited Financial Statements are an integral part of these financial statements.

 

 

 

4


Sun Hydraulics Corporation

Consolidated Statements of Comprehensive Income (unaudited)

(in thousands)

 

 

 

Three months ended

 

 

 

April 1, 2017

 

 

April 2, 2016

 

 

 

(unaudited)

 

 

(unaudited)

 

Net income

 

$

10,211

 

 

$

8,208

 

Other comprehensive income

 

 

 

 

 

 

 

 

Foreign currency translation adjustments, net of tax

 

 

1,951

 

 

 

318

 

Unrealized gain on available-for-sale securities, net of tax

 

 

129

 

 

 

196

 

Total other comprehensive income

 

 

2,080

 

 

 

514

 

Comprehensive income

 

$

12,291

 

 

$

8,722

 

 

The accompanying Notes to the Consolidated, Unaudited Financial Statements are an integral part of these financial statements.

 

 

5


Sun Hydraulics Corporation

Consolidated Statement of Changes in Shareholders’ Equity (unaudited)

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Capital in

 

 

 

 

 

 

other

 

 

 

 

 

 

 

Preferred

 

 

Preferred

 

 

Common

 

 

Common

 

 

excess of

 

 

Retained

 

 

comprehensive

 

 

 

 

 

 

 

shares

 

 

stock

 

 

shares

 

 

stock

 

 

par value

 

 

earnings

 

 

income (loss)

 

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2016

 

 

-

 

 

$

-

 

 

 

26,936

 

 

$

27

 

 

$

89,718

 

 

$

162,485

 

 

$

(15,833

)

 

$

236,397

 

Shares issued, Restricted Stock

 

 

 

 

 

 

 

 

 

 

71

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

-

 

Shares issued, other compensation

 

 

 

 

 

 

 

 

 

 

7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

-

 

Shares issued, ESPP

 

 

 

 

 

 

 

 

 

 

7

 

 

 

 

 

 

 

205

 

 

 

 

 

 

 

 

 

 

 

205

 

Shares issued, shared distribution

 

 

 

 

 

 

 

 

 

 

16

 

 

 

 

 

 

 

601

 

 

 

 

 

 

 

 

 

 

 

601

 

Stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

785

 

 

 

 

 

 

 

 

 

 

 

785

 

Dividends declared

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(2,966

)

 

 

 

 

 

 

(2,966

)

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

10,211

 

 

 

 

 

 

 

10,211

 

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2,080

 

 

 

2,080

 

Balance, April 1, 2017

 

 

-

 

 

$

-

 

 

 

27,037

 

 

$

27

 

 

$

91,309

 

 

$

169,730

 

 

$

(13,753

)

 

$

247,313

 

 

The accompanying Notes to the Consolidated, Unaudited Financial Statements are an integral part of these financial statements.

 

 

6


Sun Hydraulics Corporation

Consolidated Statements of Cash Flows

(in thousands)

 

 

 

Three months ended

 

 

 

April 1, 2017

 

 

April 2, 2016

 

 

 

(unaudited)

 

 

(unaudited)

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

Net income

 

$

10,211

 

 

$

8,208

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

5,091

 

 

 

2,527

 

Loss on disposal of assets

 

 

139

 

 

 

10

 

Stock-based compensation expense

 

 

975

 

 

 

1,425

 

Amortization of debt issuance costs

 

 

70

 

 

 

-

 

Allowance for doubtful accounts

 

 

63

 

 

 

5

 

Provision for slow moving inventory

 

 

466

 

 

 

-

 

Benefit for deferred income taxes

 

 

(12

)

 

 

(10

)

Amortization of acquisition related inventory step-up

 

 

1,774

 

 

 

-

 

(Increase) decrease in:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(11,766

)

 

 

(5,954

)

Inventories

 

 

(3,952

)

 

 

320

 

Income taxes receivable

 

 

371

 

 

 

123

 

Other current assets

 

 

(1,183

)

 

 

(1,112

)

Other assets

 

 

197

 

 

 

86

 

Increase (decrease) in:

 

 

 

 

 

 

 

 

Accounts payable

 

 

4,566

 

 

 

1,439

 

Accrued expenses and other liabilities

 

 

1,508

 

 

 

2,032

 

Income taxes payable

 

 

3,765

 

 

 

1,652

 

Other noncurrent liabilities

 

 

150

 

 

 

(260

)

Net cash provided by operating activities

 

 

12,433

 

 

 

10,491

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Investment in licensed technology

 

 

-

 

 

 

(850

)

Capital expenditures

 

 

(758

)

 

 

(999

)

Proceeds from dispositions of equipment

 

 

-

 

 

 

2

 

Purchases of short-term investments

 

 

-

 

 

 

(4,278

)

Proceeds from sale of short-term investments

 

 

2,096

 

 

 

6,429

 

Net cash provided by investing activities

 

 

1,338

 

 

 

304

 

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Repayment of borrowings on revolving line of credit

 

 

(16,000

)

 

 

-

 

Proceeds from stock issued

 

 

205

 

 

 

213

 

Dividends to shareholders

 

 

(2,963

)

 

 

(3,482

)

Change in restricted cash

 

 

-

 

 

 

1

 

Net cash used in financing activities

 

 

(18,758

)

 

 

(3,268

)

Effect of exchange rate changes on cash and cash equivalents

 

 

1,172

 

 

 

442

 

Net (decrease) increase in cash and cash equivalents

 

 

(3,815

)

 

 

7,969

 

Cash and cash equivalents, beginning of period

 

 

74,221

 

 

 

81,932

 

Cash and cash equivalents, end of period

 

$

70,406

 

 

$

89,901

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

 

 

 

Cash paid:

 

 

 

 

 

 

 

 

Income taxes

 

$

366

 

 

$

1,397

 

Interest

 

$

658

 

 

$

-

 

Supplemental disclosure of noncash transactions:

 

 

 

 

 

 

 

 

Common stock issued for shared distribution through accrued expenses and other

   liabilities

 

$

601

 

 

$

1,600

 

Unrealized gain on available for sales securities

 

$

129

 

 

$

196

 

 

The accompanying Notes to the Consolidated, Unaudited Financial Statements are an integral part of these financial statements.

7


SUN HYDRAULICS CORPORATION

NOTES TO THE CONSOLIDATED, UNAUDITED FINANCIAL STATEMENTS

(In thousands except share and per share data)

 

 

1. COMPANY BACKGROUND

Sun Hydraulics Corporation (“Sun” or the “Company”), together with its wholly-owned subsidiaries, is an industrial technology leader that develops and manufactures solutions for both the hydraulics and electronics markets. Sun operates in two business segments:  Hydraulics and Electronics. The Hydraulics segment consists of all of the global, historical Sun Hydraulics companies and serves the hydraulics market as a leading manufacturer of high-performance screw-in hydraulic cartridge valves, electro-hydraulics, manifolds, and integrated package solutions for the worldwide industrial and mobile hydraulics markets. The Electronics segment is served by two of Sun’s wholly-owned subsidiaries: Enovation Controls, LLC, (“Enovation Controls”) and High Country Tek (“HCT”). Enovation Controls is a global provider of innovative electronic control, display and instrumentation solutions for both recreational and off-highway vehicles, as well as stationary and power generation equipment. HCT is an independent designer and producer of modular, robust, reliable digital and analog electronic controller products for the fluid power industry.

The accompanying unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for reporting on Form 10-Q. Accordingly, certain information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements are not included herein. The financial statements are prepared on a consistent basis (including normal recurring adjustments) and should be read in conjunction with the consolidated financial statements and related notes contained in the Annual Report on Form 10-K for the fiscal year ended December 31, 2016, filed by Sun Hydraulics Corporation with the Securities and Exchange Commission on February 28, 2017. In Management’s opinion, all adjustments necessary for a fair presentation of the Company’s financial statements are reflected in the interim periods presented. Operating results for the three month period ended April 1, 2017, are not necessarily indicative of the results that may be expected for the period ending December 30, 2017.

 

 

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Reclassifications

Certain reclassifications have been made to the prior period consolidated financial statements to conform to the current period presentation.

Recently Adopted Accounting Standards

In July 2015, the FASB issued ASU 2015-11, Inventory: Simplifying the Measurement of Inventory. ASU 2015-11 requires that inventory be measured at the lower of cost and net realizable value. Additionally, the guidance defines net realizable value as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The guidance became effective, and was adopted prospectively, for the first quarter of fiscal year 2017. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation: Improvements to Employee Shared-Based Payment Accounting. ASU 2016-09 is intended to simplify several aspects of accounting for share-based payment awards. The new guidance became effective and was adopted for the first quarter of fiscal year 2017. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.

Recently Issued Accounting Standard

In March 2017, the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs. ASU 2017-08 shortens the amortization period for certain callable debt securities held at a premium, requiring the premium to be amortized to the earliest call date. The standard is effective for annual and interim periods beginning after December 15, 2018. The Company does not expect the adoption of this guidance to have a material impact on the consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other: Simplifying the Test for Goodwill Impairment. ASU 2017-04 eliminates the second step in the goodwill impairment test which requires an entity to determine the implied fair value of the reporting unit’s goodwill. Instead, an entity should recognize an impairment loss if the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, with the impairment loss not to exceed the amount of goodwill allocated to the reporting unit. The standard is effective for annual and interim goodwill impairment tests conducted in fiscal years beginning after December 15, 2019, with early adoption permitted. The Company does not expect the adoption of this guidance to have a material impact on the consolidated financial statements.

8


In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments. The guidance is effective for annual and interim periods beginning after December 15, 2017. Early adoption is permitted. The Company does not expect the adoption of this guidance to have a material impact on the consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses: Measurement of credit losses on Financial Instruments. The new impairment model requires immediate recognition of estimated credit losses expected to occur for most financial assets and certain other instruments. For available-for-sale debt securities with unrealized losses, the losses will be recognized as allowances rather than reductions in the amortized cost of the securities. It is effective for annual reporting periods beginning after December 15, 2019 and interim periods within those annual periods. Early adoption for fiscal years beginning after December 15, 2018 is permitted. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first effective reporting period. The Company does not expect the adoption of this guidance to have a material impact on the Company’s consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases. ASU 2016-02 requires an entity to recognize both assets and liabilities arising from financing and operating leases, along with additional qualitative and quantitative disclosures. The guidance is effective for reporting periods beginning after December 15, 2018 with early adoption permitted. The Company is currently evaluating the effects, if any, adoption of this guidance will have on the Company’s consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities.  ASU 2016-01 primarily affects equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. Among other things, this new guidance requires certain equity investments to be measured at fair value with changes in fair value recognized in net income. This standard is effective in 2018 with certain provisions allowing for early adoption. The Company is currently evaluating the effects, if any, adoption of this guidance will have on the Company’s consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. Subsequent updates to the guidance were issued in 2016. The core principle of the new guidance is that an entity will recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. The standard provides a five-step analysis of transactions to determine when and how revenue is recognized. Additionally, the guidance requires disaggregated disclosures related to the nature, amount, timing, and uncertainty of revenue that is recognized. The guidance is effective for annual and interim periods beginning on or after December 15, 2017.

The guidance permits two methods of adoption: retrospectively to each prior reporting period presented, or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application. The Company is in the initial stages of evaluating this standard in relation to arrangements with customers and believes that the current revenue arrangements in place are of lower complexity. The Company’s evaluation and implementation of this new guidance will be timely completed during 2017, at which time a conclusion regarding the transition method will be disclosed.

Earnings per share

The following table represents the computation of basic and diluted earnings per common share (in thousands, except per share data):

 

 

 

Three Months Ended

 

 

 

April 1, 2017

 

 

April 2, 2016

 

Net income

 

$

10,211

 

 

$

8,208

 

Basic and diluted weighted average shares outstanding

 

 

26,946

 

 

 

26,804

 

Basic and diluted net income per common share

 

$

0.38

 

 

$

0.31

 

 

 

3.  BUSINESS ACQUISITION

On December 5, 2016 (the “Acquisition Date”), the Company completed the acquisition of Enovation Controls, LLC, a global provider of electronic control, display and instrumentation solutions.  Historically Enovation Controls sold products to four customer markets: natural gas production controls (NGPC), engine controls and fuel systems (ECFS), power controls (PC) and vehicle technologies (VT).  Prior to the closing date, and pursuant to an Asset Transfer Agreement, Enovation Controls transferred the assets and liabilities of their lines of business associated with the NGPC and ECFS customer markets to a separate legal entity, leaving Enovation Controls with only the lines of business associated with the PC and VT customer markets and the related agreed upon assets and liabilities to be acquired by Sun.  

9


Pursuant to a Unit Purchase Agreement, Sun acquired all of the outstanding membership units of Enovation Controls for initial cash consideration of $201,020 and additional cash earn-out potential of $50,000.  Total consideration for the acquisition was subject to a post-closing adjustment for working capital in accordance with the terms of the Purchase Agreement.  During the first quarter of 2017 the Company recognized an additional $500 of consideration for the post-closing working capital adjustment.  The consideration paid for the acquisition was funded with cash on hand and proceeds from the existing revolving line of credit as discussed in further detail in Note 7.

The acquisition of Enovation Controls enables the Company to expand its current complete system solution portfolio by developing product and end market diversification.  The results of Enovation Controls’ operations have been included in the consolidated financial statements since the Acquisition Date.  

The fair value of total purchase consideration consisted of the following:

 

Cash

 

$

201,020

 

Fair value of contingent consideration

 

 

35,077

 

Post closing adjustment for working capital

 

 

500

 

Total purchase consideration

 

 

236,597

 

Less: cash acquired

 

 

(964

)

Total purchase consideration, net of cash acquired

 

$

235,633

 

The contingent consideration arrangement requires the Company to pay up to $50,000 of additional consideration to Enovation Controls’ former owners based on defined revenue and EBITDA targets. The potential payments are due in three installments, to be paid during the 9, 18 and 27 month periods after closing. The preliminary fair value of the contingent consideration arrangement at the acquisition date was $35,077 and was estimated using a risk-adjusted probability analysis as of the Acquisition Date.  

The purchase price was allocated to tangible and intangible assets acquired and liabilities assumed based on their estimated fair values.  The fair value of identifiable intangible assets acquired was based on estimates and assumptions made by management at the time of the acquisition. Management is currently awaiting additional information to complete the valuation of contingent consideration, identified intangible assets and related deferred income taxes. As additional information, as of the acquisition date, becomes available and as management completes its evaluation, the preliminary purchase price allocation may be revised during the remainder of the measurement period (which will not exceed 12 months from the Acquisition Date). Any such revisions or changes may be material as the fair values of the tangible and intangible assets acquired and liabilities assumed are finalized.

The preliminary allocation of the total purchase price, net of cash acquired, is as follows:

 

Accounts receivable

 

$

9,502

 

Inventories

 

 

16,979

 

Other current assets

 

 

176

 

Property, plant and equipment

 

 

10,546

 

Goodwill

 

 

99,167

 

Intangible assets

 

 

108,070

 

Other assets

 

 

8

 

Total assets acquired

 

 

244,448

 

Accounts payable

 

 

(3,260

)

Accrued expenses and other liabilities

 

 

(3,745

)

Deferred income taxes

 

 

(1,810

)

Total liabilities assumed

 

 

(8,815

)

Fair value of net assets acquired

 

$

235,633

 

Goodwill is primarily attributable to the assembled workforce, new product development capabilities and anticipated synergies and economies of scale expected from the operations of the combined company. The synergies include certain cost savings, operating efficiencies, and other strategic benefits projected to be achieved as a result of the acquisition.  All goodwill is expected to be deductible for tax purposes.

10


Intangible Assets

The preliminary fair value of identified intangible assets and their respective useful lives are as follows:

 

 

 

Fair Value

 

 

Weighted-

Average

Amortization

Periods (Yrs)

 

Brands

 

$

30,000

 

 

 

20

 

Non-compete Agreements

 

 

950

 

 

 

5

 

Technology

 

 

17,500

 

 

 

9

 

Supply Agreement

 

 

21,000

 

 

 

10

 

Sales Order Backlog

 

 

620

 

 

 

1

 

Customer Relationships

 

 

38,000

 

 

 

20

 

Identified intangible assets

 

$

108,070

 

 

 

16

 

Unaudited Pro Forma Information

The following unaudited pro forma financial information presents combined results of operations for each of the periods presented, as if Enovation Controls had been acquired as of the beginning of 2016.  The financial results of Enovation Controls included in the pro forma information provided below reflect net sales and direct costs and operating expenses related to the acquired lines of business only.

The PC and VT lines of business were not separate legal entities and were never operated as stand-alone businesses, divisions or subsidiaries and Enovation Controls had never maintained the distinct and separate accounts necessary to prepare full carve out financial statements. Due to the impracticability of obtaining full financial information for the carve-out operations, certain costs of Enovation Controls, primarily related to corporate overhead, foreign currency translation gains and losses and interest expense are not included in the pro forma results prior to the Acquisition Date.

The pro forma information includes adjustments to interest expense, income tax provision, amortization and depreciation for intangible assets and property, plant and equipment acquired and net sales and cost of sales for the effects of the supply agreement entered into at the Acquisition Date. The pro forma information does not reflect any operating efficiencies or potential cost savings that may result from the acquisition. Accordingly, the pro forma information is for illustrative purposes only and is not intended to present or be indicative of the actual results of operations of the combined company that may have been achieved had the acquisition actually occurred at the beginning of 2016, nor is it intended to represent or be indicative of future results of operations of the combined business. Consequently, actual results will differ from the unaudited pro forma information presented below:

 

 

 

Three months ended

 

 

 

April 2, 2016

 

Net sales

 

$

70,855

 

Operating income

 

 

13,765

 

Net income

 

 

9,105

 

Basic and diluted net income per common share

 

 

0.34

 

 

 

4.  FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company applies fair value accounting guidelines for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Under these guidelines, fair value is defined as the price that would be received for the sale of an asset or paid to transfer a liability (i.e. an exit price) in an orderly transaction between market participants at the measurement date. The guidance establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value as follows:

Level 1 - Quoted prices in active markets for identical assets or liabilities.

Level 2 - Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets or liabilities in inactive markets.

Level 3 - Unobservable inputs that are supported by little, infrequent, or no market activity and reflect the Company’s own assumptions about inputs used in pricing the asset or liability.

11


The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The Company’s valuation techniques used to measure the fair value of marketable equity securities were derived from quoted prices in active markets for identical assets or liabilities. Contingent consideration and newly acquired intangible assets are measured at fair value using level 3 inputs. The valuation techniques used to measure the fair value of all other financial instruments were valued based on quoted market prices or model driven valuations using significant inputs derived from or corroborated by observable market data.

The Company’s short-term investments have been classified and accounted for as available-for-sale. Management determines the appropriate classification of its investments at the time of purchase and reevaluates the designation at each balance sheet date. The Company may or may not hold securities with stated maturities greater than 12 months until maturity. As management views these securities as available to support current operations, the Company classifies securities with maturities beyond 12 months as current assets under the caption short-term investments in the accompanying Consolidated Balance Sheets. The Company’s short-term investments are carried at fair value, with the unrealized gains and losses, net of tax, reported as a component of shareholder’s equity. Realized gains and losses on sales of short-term investments are generally determined using the specific identification method, and are included in miscellaneous expense, net in the Consolidated Statements of Operations.

The following tables provide information regarding the Company’s assets and liabilities measured at fair value on a recurring basis at April 1, 2017 and December 31, 2016. The fair value of cash and cash equivalents, accounts receivable, other current assets, accounts payable and accrued expenses and other liabilities approximates their carrying value, due to their short-term nature.

 

 

 

April 1, 2017

 

 

 

Adjusted Cost

 

 

Unrealized Gains

 

 

Unrealized Losses

 

 

Fair Value

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Level 1:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

$

-

 

 

$

22

 

 

$

-

 

 

$

22

 

Mutual funds

 

 

1,483

 

 

 

-

 

 

 

(148

)

 

 

1,335

 

Subtotal

 

 

1,483

 

 

 

22

 

 

 

(148

)

 

 

1,357

 

Level 2:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate fixed income

 

 

2,297

 

 

 

13

 

 

 

(224

)

 

 

2,086

 

Municipal bonds

 

 

1,341

 

 

 

-

 

 

 

(80

)

 

 

1,261

 

Subtotal

 

 

3,638

 

 

 

13

 

 

 

(304

)

 

 

3,347

 

Total

 

$

5,121

 

 

$

35

 

 

$

(452

)

 

$

4,704

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Level 3:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contingent consideration

 

 

 

 

 

 

 

 

 

 

 

 

 

$

35,077

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

$

35,077

 

 

 

 

December 31, 2016

 

 

 

Adjusted Cost

 

 

Unrealized Gains

 

 

Unrealized Losses

 

 

Fair Value

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Level 1:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

$

-

 

 

$

31

 

 

$

-

 

 

$

31

 

Mutual funds

 

 

1,483

 

 

 

-

 

 

 

(159

)

 

 

1,324

 

Subtotal

 

 

1,483

 

 

 

31

 

 

 

(159

)

 

 

1,355

 

Level 2:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate fixed income

 

 

4,288

 

 

 

9

 

 

 

(408

)

 

 

3,889

 

Municipal bonds

 

 

1,675

 

 

 

-

 

 

 

(94

)

 

 

1,581

 

Subtotal

 

 

5,963

 

 

 

9

 

 

 

(502

)

 

 

5,470

 

Total

 

$

7,446

 

 

$

40

 

 

$

(661

)

 

$

6,825

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Level 3:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contingent consideration

 

 

 

 

 

 

 

 

 

 

 

 

 

$

35,077

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

$

35,077

 

 

The Company recognized a net realized loss on investments during the three months ended April 1, 2017 of $267 and a net realized loss of $63 during the three months ended April 2, 2016. As of April 1, 2017, gross unrealized losses related to individual securities

12


that had been in a continuous loss position for 12 months or longer were not significant. The Company considers these unrealized losses in market value of its investments to be temporary in nature. When evaluating an investment for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below its cost basis, the financial condition of the issuer and any changes thereto, and the Company’s intent to sell, or whether it is more likely than not it will be required to sell, the investment before recovery of the investment’s cost basis. During the three months ended April 1, 2017, the Company recognized an impairment charge of $220, which is included in the net realized loss for the period.  There were no other-than-temporary impairments during the three month period ended April 2, 2016.

Maturities of investments at April 1, 2017 are as follows:

 

 

 

Adjusted Cost

 

 

Fair Value

 

Due in less than one year

 

$

101

 

 

$

104

 

Due after one year but within five years

 

 

1,839

 

 

 

1,653

 

Due after five years but within ten years

 

 

967

 

 

 

923

 

Due after ten years

 

 

731

 

 

 

667

 

Total

 

$

3,638

 

 

$

3,347

 

 

The Company did not have any fair value adjustments for assets and liabilities measured at fair value on a nonrecurring basis during the period ended April 1, 2017.

 

 

5.  INVENTORIES

 

 

 

April 1, 2017

 

 

December 31, 2016

 

Raw materials

 

$

19,797

 

 

$

16,864

 

Work in process

 

 

5,977

 

 

 

5,641

 

Finished goods

 

 

7,417

 

 

 

8,069

 

Provision for slow moving inventory

 

 

(1,276

)

 

 

(574

)

Total

 

$

31,915

 

 

$

30,000

 

 

 

6.  GOODWILL AND INTANGIBLE ASSETS

A summary of changes in goodwill at April 1, 2017 is as follows:

 

 

 

Hydraulics

 

Electronics

 

Total

 

Balance at December 31, 2016